Real estate as an investment - A case study
This is an analysis done which helps real estate investors
understand what kind of returns they should expect. This study is by no means done
to undermine the potential of real estate as an asset. Real estate in the past
decade has given stellar returns. I certainly hope the performance will be
repeated in the coming years. This research illustrates the higher risk involved when we invest in real estate by purely looking at past returns. I certainly hope a salaried middle class investor does not fall prey to lure of real estate and he understands the risk involved. Happy investing :-)
Real estate investment can be in the form of apartment, villa or a
plot. The investment in the form of apartment or a villa is the best case as
there is rental income involved and they also qualify for the tax exemption. For
the case study I have taken the example of an apartment in the "A"
grade area. The example city under consideration is Bangalore and the locality
is Outer Ring Road. The sample property is Adarsh Palm Retreat located very
close to many IT companies, malls and educational institutions. The completion
date of the project is Dec 2013. The size of the Apartment is 1700 sq ft and a
3 BHK apartment. The apartment was booked on May 2011 at a price of 3700 rs per
sq ft. With the Addition of twin car park, sales tax, BWSSB, BESCOM and
maintenance the total cost comes to 78 lakhs. The registration cost comes to 3
lakhs which takes the cost to 81 lakhs.
Cost of Acquisition
Assuming a home loan of 81 lakhs for a term of 20 years and
interest rate of 10%, the EMI comes to 78200 rs per month.
Investment Performance -
This section details the cost of owning the apartment at 5, 10, 15
and 20 year term. Also it depicts the performance of other assets had you
chosen to invest in them.
in the below table i have illustrated how much the apartment should perform to just MATCH the recurring deposit return. After the table is the thorough calculation and the details.
I have not compared the returns of the stock markets as it is a risky asset.
Performance
of various assets while the apartment and corresponding performance real estate
should deliver to match them
Term
Asset
|
5 year
|
10 Year
|
15 Year
|
20 Year
|
|
Asset 1
|
Recurring Deposit (EMI amount every month in RD)(Post Tax return)
|
5844110 ( total Value)1152110 ( gain after 5 years)
post tax gain =5498477
|
14835998 (total value)
5451998 ( gain after 10 years)
post tax gain =13200398
|
28671133(total value)
14595133 (gain after 15 years)
post tax gain =24292593
|
49958200(total value)
31190200 (gain after 20 years)
post tax total value =40601140
|
Asset 2
|
Apartment (The Apartment should grow to this value to match
RD return) ( per sq ft values)
|
9900
|
17000
|
22000
|
29000
|
5 year period
After a 5 year period below are the numbers
Cost of acquisition
EMI payment for 5 years - 4692000
Principal Remaining - 7273000
Total Cost at 5 years - 11965000
Total Income from the apartment
a
|
Rental
Return (assuming a rent of 30000 avg per month for the period of 5 years)
|
1800000
|
b
|
Income
Tax Benefit qualifying interest
|
3864000
|
c
|
Real
Income Tax Benefit (Since the rental is taxed at 30% the real benefit would
be the difference of interest and rental income)
30 % of (b – a )
|
460000
|
d
|
Total income
Rental
income + Real income tax benefit (a +C)
|
2260000
|
Total Expense from the apartment
a
|
Monthly maintenance @ 5 rs
per sq ft
|
5 * 1700 = 8500
|
b
|
Maintenance for 5 years ( a * 120)
|
510000
|
c
|
Property Tax ( 10000rs annually)
|
50000
|
d
|
Long term capital gain tax(20% of
the gain amount)( we are taking the sale price as 6000 rs per sqft as our intent is to figure out the minimum
amount to break even)
|
(6000-3700)*1700@20%
tax rate = 782000
|
e
|
Total
Expenditure
(b+c+d)
|
1342000
|
Net income from the apartment (total income – total
expense) = 2260000 – 1342000 = 918000
Total Cost of
Acquisition = 11965000 – 918000 = 11047000
So to justify the cost of acquisition the per sqft value of apartment
should increase up to 6500 rs per sq ft.
Since the buying per sq ft cost is 3700 the appreciation
percentage should be a whopping 75% just to break even
Other Asset performance
Asset Name
|
Bank RD
|
Stock Market
(8.5%) last 6 years
|
4090877
|
5773000
|
10 year period
After a 10 year period below are the numbers
Cost of acquisition
EMI payment for 10 years – 9384000
Principal Remaining – 5914000
Total Cost at 10 years – 15298000
Total Income from the apartment
a
|
Rental Return (assuming a rent of
45000 avg per month for the period of 10 years)
|
5400000
|
b
|
Income Tax Benefit qualifying
interest
|
7194980
|
c
|
Real Income Tax Benefit (Since the
rental is taxed at 30% the real benefit would be the difference of interest
and rental income) 30 % of (b – a )
|
538494
|
d
|
Total income
Rental income + Real income tax
benefit (a +C)
|
5938494
|
Total Expense from the apartment
a
|
Monthly maintenance @
10 rs per sq ft
|
10 *
1700 = 17000
|
b
|
Maintenance
for 10 years ( a * 120)
|
2040000
|
c
|
Property
Tax ( 13000rs annually)
|
130000
|
d
|
Long term capital gain tax(20% of
the gain amount)( we are taking the sale price as 7000 rs per sqft as our intent is to figure out the minimum
amount to break even)
|
(7000-3700)*1700@20% tax rate = 1122000
|
e
|
Total
Expenditure
(b+c+d)
|
3292000
|
Net income from the apartment (total income – total
expense) = 5938494 – 3292000 = 2646494
Total
Cost of Acquisition = 15298000 - 2646494 = 12651506
So
to justify the cost of acquisition the per sqft value of apartment should
increase up to 7500 rs per sq ft.
Since the buying per sq
ft cost is 3700 the appreciation percentage should be a 102%
just to break even. As per below table we would need the apartment to
appreciate by 250% to match RD returns (@ 17000 per sq ft) .
Other Asset performance
Asset Name
|
Bank RD (post tax @ 30%)
|
Stock Market (16%) last 10 years
|
10385200
|
21436000
|
15 year period
After a 15 year period below are the numbers
Cost of acquisition
EMI payment for 15 years - 14076000
Principal Remaining - 3678900
Total Cost at 15 years - 17754900
Total Income from the apartment
a
|
Rental
Return (assuming a rent of 60000 avg per month for the period of 15 years)
|
10800000
|
b
|
Income
Tax Benefit qualifying interest
|
9648900
|
c
|
Real
Income Tax Benefit (Since the rental is taxed at 30% the real benefit would
be the difference of interest and rental income)
30 % of (b – a )
|
345330
|
d
|
Total income
Rental
income + Real income tax benefit (a +C)
|
11145330
|
a
|
Monthly maintenance @ 15
rs per sq ft
|
15 * 1700 = 25500
|
|
b
|
Maintenance for 15 years ( a * 120)
|
4590000
|
|
c
|
Property Tax ( 15000 rs annually)
|
225000
|
|
d
|
Long
term capital gain tax(20% of the gain amount)( we are taking the sale price
as 7000 rs per sqft as our intent is
to figure out the minimum amount to break even)
|
(7000-3700)*1700@20% tax rate = 1122000
|
|
e
|
Total
Expenditure
(b+c+d)
|
5937000
|
Net income from the apartment (total income - total
expense) = 11145330 – 5937000 = 5208330
Total Cost of Acquisition
= 17754900 – 5208330 =
12546570
So
to justify the cost of acquisition the per sqft value of apartment should
increase up to 7300 rs per sq ft.
Since the buying per sq ft cost is 3700 the appreciation
percentage should be a 98% just to break even.
Other Asset performance
Asset Name
|
Bank RD (post tax @ 30%)
|
Stock Market (16%) last 10 years
|
20069793
|
51937048
|
20 year period
After a 20 year period below are the numbers
Cost of acquisition
EMI payment for 20 years - 18768000
Principal Remaining - 0
Total Cost at 20 years - 18768000
Total Income from the apartment
a
|
Rental Return (assuming a rent of 12000
avg per month for the period of 20 years)
|
28800000
|
b
|
Income Tax Benefit qualifying
interest
|
0
|
c
|
Real Income Tax Benefit (Since the
rental is taxed at 30% the real benefit would be the difference of interest
and rental income) 30 % of (b – a )
|
0
|
d
|
Total income
Rental income + Real income tax
benefit (a +C)
|
28800000
|
a
|
Monthly maintenance @ 20
rs per sq ft
|
20 * 1700 = 34000
|
|
b
|
Maintenance for 20 years ( a *240)
|
8160000
|
|
c
|
Property Tax ( 20000 rs annually)
|
400000
|
|
d
|
Long
term capital gain tax(20% of the gain amount)( we are taking the sale price
as 8000 rs per sqft as our intent is
to figure out the minimum amount to break even)
|
(8000-3700)*1700@20% tax rate = 1462000
|
|
e
|
Tax hit because of rental income
|
28800000@30%=8640000
|
|
f
|
Total
Expenditure
(b+c+d+e)
|
18662000
|
Net income from the apartment (total income - total
expense) = 28800000 – 18662000 = 10138000
Total Cost of Acquisition = 18768000
– 10138000 = 8630000
So
to justify the cost of acquisition the per sqft value of apartment should
increase up to 5000 rs per sq ft.
Other Asset performance
Asset Name
|
Bank RD (post tax @ 30%)
|
Stock Market (16%) last 20 years
|
34970742
|
116000000
|
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